I Told You So

What is so great about the “Bazooka”? It does nothing to reduce the amount of debt that is going to be in circulation. It doesn’t guarantee debt that is already in circulation. It doesn’t guarantee debt that will be sold to private investors. The real weapon is the ECB intervention in the bond markets. If they can convince investors to hold on to their PIIGS bonds, then things might calm down. But for how long? If the ECB really buys the debt, it will be exposed to the risk of haircuts, too. That way, the debt that the ECB buys ends up in the treasuries of European countries, who would have to bail out the ECB.

As some economists already acknowledge, this is again an issue of solvency, not liquidity. Politicians are again confusing those two things. In three years Greece and Portugal will still be bankrupt. If the ECB intervention doesn’t work, and the Euro fires the bazooka, then they will really go ‘all in’. From that moment on, a debt rescheduling with haircuts will be no option anymore, because it would mean heavy losses to all Euro area governments. They will mess around for some time trying to convince the PIIGS to reduce their debt, until the PIIGS start leaving the Euro. Ironically, this would most certainly lead to a sudden stop in debt payments by those countries, which would result in the haircuts for the non-PIIGS countries that they wanted to prevent in the first place.

The only way to get out of this mess without destroying the Euro area would be instant debt rescheduling now, before they have to use the bazooka.

Meanwhile, the latest Greek budget projections show that they have reduced their primary deficit (before interest payments) to zero in the coming months. This means that they do not need to issue debt to finance all government expenses. The whole deficit will consist of interest payments only. So, in other words, they are free to declare default, or even leave the Euro, or both, as they do not need access to capital markets anymore.

The biggest mistake for the other Euro members now would be to pour additional funding into Greece, as that would only increase the amount of money that could be lost forever once Greece defaults.